A LANDMARK program connecting Shanghai and Hong Kong stock markets is finally starting to attract more global institutional investors, as a lag in trading and settlements that posed a risk to investors has been ironed out.

    More institutional activity on the platform will likely speed up reforms and the rollout of another program linking Shenzhen and Hong Kong, market participants say.

    “I dismiss the thought that it is only a retail product,” said Kevin Rideout, head of business development at the Hong Kong stock exchange. “What I can see is that the recent top 10 overall stock connect volumes are made up from the international firms and that probably tells me that it’s largely institutional.”

    Launched in November 2014, the Shanghai-Hong Kong Stock Connect had promised to open up the mainland’s capital markets to foreign investors, heralding bolder stock market reforms with the ultimate goal of full capital account convertibility. Instead, it was criticized for being used by retail investors and hedge funds to dabble in mainland markets.

    Quotas inbound and outbound have not been fully used up, aggravated by a mid-year stock market crash in 2015 and volatility in the yuan that spooked investors.

    The failure of the program to draw institutions, such as insurance companies and funds, forced regulators to postpone the launch of the Shenzhen project and also from expanding the scope of the existing program.

    Recent reforms, however, particularly in stock delivery and settlement services, have removed some uncertainty for investors.

    Connect brokers were hopeful of more institutional participation since last year but problems around settlement issues were only resolved in April.

    The Chinese mainland follows a unique T+0 settlement model — shares are exchanged on the day they are traded but funds are transferred the following day. In most markets, including Hong Kong, a T+2 model is followed. A lag in settlement gives rise to broker counterparty risks.

    This last setback was ironed out in April when a “delivery versus payment (DVP)” model was introduced.

    “We are seeing more institutional flows on our platform going into the northbound leg with more participation from the European funds,” said the head of electronic trading at a U.S. bank in Hong Kong.

    While overall aggregate quota utilization on the Shanghai leg of the program remains low at 42 percent, below a peak of 57 percent last June, there are signs of a pick-up.

    Greater institutional participation bodes well for the mainland stock markets at a time when turnover on the Shanghai bourse is near its lowest point this year.

    The share of the top-ranked broker category, which services institutional clients, has grown recently and accounts for nearly 70 percent of turnover on the mainland-bound leg, Hong Kong stock exchange data show.

    “We are definitely seeing more institutional clients on our platforms focused on stock connect and the cheap valuations are an additional attraction,” said Andrew Sullivan, managing director of sales trading at Haitong International Securities in Hong Kong.

    The Shenzhen-Hong Kong stock connect program is expected to offers global investors an opportunity to diversify into China’s tech and service companies, which has proved much more resilient to slowing growth in the world’s second-largest economy.

    “The Shenzhen exchange has a far more diverse mix of companies that reflects China’s new consumer and tech-driven growth prospects,” said Gao Ting, chief of China equities strategist at UBS Securities. (SD-Agencies)